The Scariest Debt Chart In America Has One Gigantic Flaw

There's no question that you've seen charts like this before.
This one is from Paul Ryan. The point he makes is that if we
don't get our spending on Medicare under control, the economy
will be overwhelmed by government debt, and that a Greek-like
future is sure to be in the cards.

Now all charts are quite this dramatic looking, but you get the
point. We're supposedly HOSED unless we don't come up with a
scheme soon to cut healthcare spending on America's seniors.

First of all, he notes that they're not actually macroeconomic
forecasts, but baselines done by the CBO, so they can asses the
budgetary impact of a given law.

But there's another reason why the charts are inherently flawed.
They assume a scary trajectory in healthcare inflation going out
years. But if that were to happen, then healthcare would grow to
a gigantic share of GDP, and take on a growing share of the CPI,
and that would mean nominal GDP would grow much faster than what
people estimate, meaning the denominator of the debt-to-GDP ratio
(GDP) would be much bigger than anticipated.

In other words, they assume healthcare inflation in isolation,
but don't assume that other inflation or GDP will keep up, an
impossibility if healthcare inflation gets as bad as it is. So
either healthcare inflation will keep soaring (and that will lift
up other measures, like nominal GDP) or a combination of market
and government forces will bend down the cost curve (something
that's already happening) and the doomsday scenario isn't that
bad.

BI: When people look at these CBO charts showing national
debt-to-GDP soaring into the future if everything is left
unchecked - obviously that prompts a lot of knee-jerk concern
that this is inherently unsustainable for some reason. What is
your response to that?

JG: First of all, I say read the fine print
and you will see that the CBO itself says that these charts are
not macroeconomic forecasts. They are baselines. Their function -
the reason the CBO does them - is to provide a common framework
for evaluating legislation. The CBO's function is to cost-out
legislative proposals. In order to do that in a fair way, you
have to have a common baseline for everyone. And that's what the
baseline is.

The baseline itself doesn't have to be a good macroeconomic
forecast. But if you use it as such, and i't been sort of
conscripted into that by a lot of people who, maybe, are
negligent or irresponsible, then you have to ask: Is this
baseline internally consistent? And obviously it's not. The fact
that it shows that over a long period of time, health care costs
rising to 30, 40, 50 percent of GDP, and then with their costs
continuing rising more rapidly than GDP, but overall inflation
standing at 3%, even though the share of health care costs rises
and rises and rises, is an absurdity. And it'll never happen.

BI: Explain that further.

JG: Let's flash forward half a century. If
health care costs are 50 percent of GDP, then their weight in the
inflation index will be 50 percent. And their rapidly rising
costs will be reflected in inflation, in which case inflation
will not be 3 percent. It's not difficult, it's not.

BI: Are you saying inflation will be much higher,
therefore GDP will be much higher?

Inflation will be much higher, in which case nominal GDP would be
much higher, in which case the debt GDP ratio will not be what
the CBO is predicting. I'm not saying it's a good thing - but
even before you reach that point, if medical care costs continue
to rise the way the CBO projects, other costs will weigh up to
that. But if your doctor asks for $50,000 for a tonsillectomy
you're going to be asking your boss for $250,000 in salary. It's
just not reasonable to think that the medical sector can get away
with extracting a much larger share of our GDP than it does
anywhere else in the world, and the reality of course is that it
isn't. The more you see that the cost curve is bending, that the
increase in health care costs is much lower than the CBO is
projecting.

BI: This is a crucial point, that there is no way for
these CBO debt-to-GDP charts to actually be accurate because
there is no way that you could have this one sector of the
economy swamping everything else.

JG: Correct, correct, absolutely correct.
And the second thing which is in there, and the CBO has adjusted
this since four years ago, is the assumption that interest rate
on the federal debt is going to go up higher than the growth rate
of GDP. This is compounding over time, which drives up the share
of debt-to-GDP in a very artificial way. Can't happen, won't
happen.